Customers forcing changes at PayPal

A backlash by some customers who have seen PayPal freeze their funds, sometimes for weeks at a time, is forcing the payments unit of eBay Inc to change its anti-fraud policies.

PayPal is testing new, relaxed policies that may expose the dominant online payment service to more risk as it tries to tackle an issue that has dented its reputation.

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Alex Stultz of Red Star Merchandise used the company's PayPal Here mobile service to accept card payments at the Outside Lands music festival in San Francisco in August.

The arrangement was part of a promotion by PayPal at the festival. Despite that, Stultz said some of his funds were held up by PayPal following the event. The issue was cleared up after a couple of emails and one phone call, he noted.

"I'm glad to hear they are working on it for everyone else," Stultz said. "Holding funds is tough on merchants because they need the cash flow."

PayPal says such account holds affect a small percentage of users and are needed to protect the company from big losses. But complaints have increased this year and some users are considering other ways to accept payments.

A plethora of rival payments start-ups, including Square, Stripe, Braintree and WePay, provide more options for PayPal users now, putting pressure on the company to change.

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"In the past, we took steps to protect customers and ourselves. Unfortunately, sometimes we catch a dolphin in our nets," said PayPal's new President David Marcus.

"Now that we have better technology than a few years ago, better algorithms, we can do things a little differently."

Braintree said on Wednesday that the next 1,000 businesses to sign up for its payments service would have processing fees waved on their first $50,000 worth of transactions.

With some types of transactions, involving things like event ticket sales, PayPal said it is exposed to a lot of potential fraud. An organizer could sell thousands of tickets ahead of time and then cancel the event, leaving PayPal on the hook.

"Where we have had a lot of losses in the past and we strengthened our rules, we're going to try figure out how to do a better job and potentially take more risk for the benefit of our customers," Marcus said.

PayPal is testing new, relaxed policies with a limited number of users and is monitoring the impact before deciding whether to roll them out more widely. Marcus declined to give details of the results so far.

In September, PayPal emailed some of its top-performing business users that it would no longer put holds on their funds when there was a dispute, claim or chargeback. In the past, money was placed in a "pending balance" until PayPal resolved such issues, according to the company.

WePay specializes in helping users collect payments from multiple people, making it useful for event organizers. In 2010, the start-up dumped a 600-pound block of ice outside a PayPal conference with a sign saying "PayPal freezes your accounts."

Square, led by Twitter co-founder Jack Dorsey, has gained a lot of small merchant customers by helping them accept card payments through a small swipe device that attaches to smartphones.

Stripe focuses on making it easier for website and app developers to accept payments.

PayPal's moves are part of a broader push by Marcus to make the company's payment service more customer-focused, according to Gil Luria, an analyst at Wedbush Securities.

"In terms of providing better customer service and holding funds, there's certainly a change of philosophy at PayPal and Marcus is behind a lot of that," he added.

HIGHER LOSSES

The tests may increase PayPal's losses in the short term. PayPal's loss rate was 0.30 percent in the third quarter, up from 0.26 percent in the previous quarter.

That means for every $100 of purchases PayPal processes, it paid 30 cents to cover losses. In the third quarter, PayPal handled more than $35 billion worth of transactions, up 20 percent from a year earlier. The business has about 117 million users in 190 countries.

"If the loss rate rose on its own without a corresponding return, that would be a concern for investors," Luria said.

But the changes should improve customer service and increase revenue growth by encouraging more merchants to use PayPal, he added.

"Even if there's a little higher loss rate, the incremental revenue from this will fall to the bottom line pretty quickly," Luria said. A typical loss rate for online transactions is 1 percent or more, he noted.

PayPal's policy changes may also be needed as the company expands from its online roots to try to process more transactions in the physical world, said Rick Oglesby, a payments expert at consulting firm Aite Group.

As the company works more with small merchants, like Stultz of Red Star Merchandise, there will be more spikes in payment volumes. Such spikes are often an early sign of potential fraud, which can lead to account holds, Oglesby explained.

"If PayPal treats all these offline transactions the same, their new products and services will not be workable," he added.